Introducing Economic Breezefalls

Here’s a bit of personal finance advice from the Washington Post:

Here’s another reader’s debt dilemma: “I got a huge tax refund that would . . . pay off a good chunk — about half — of my credit card debt. But I am embarrassed to say that I have no savings at all aside from my 401(k). I am wondering if I should divvy up my refund between establishing an emergency fund and paying down my credit cards. I need your common sense advice.”

The sensible thing would be to establish an emergency fund. The ideal is to have between three months and six months of household expenses in a rainy day fund. In this case just one month’s worth will do. Use the rest of the refund to reduce your credit card debt.

I disagree, partially. Keep enough cash aside to cover one month of expenses that can’t be paid with a credit card. Use the rest to pay down credit card debt. If trouble arises, run the card back up. Groceries can be purchased with a credit card, for example. Even if the break in interest is only one month, it could be significant.

Contrast that with this:

Another reader had a similar question. “I’m 25 and will receive an $8,000 tax refund this year as a new homeowner. My rainy day fund has two months’ worth of expenses, and I can’t decide between building it to a full three months first then putting the rest of the refund toward my biggest student loan, or paying the loan (9 percent interest) off entirely. I’d love to see that one loan (I have three more) disappear and not pay any more interest. But I worry that it would take another eight months to build up to a three-month reserve. What would you do?”

I would pay off the one student loan, entirely.

However, let’s get real. Most people won’t let the money just sit in a savings account. They end up spending it on a big-screen television, vacations, car repairs or whatever. Before they realize it, the windfall is gone, and yet the debt is still there.

I disagree completely. Even at 9 percent, the student loan is stable. If something happened and this person needed access to a rainy day fund, there’s nothing there. The student loan is paid off, but then the credit cards build. That’s not a reasonable trade.

I accept that both of those fit my personal preference more than anything, with a significant dose of experience in both included. Still, I find it odd to imply that a 25-year-old who can be responsible enough to buy a house and build two months of rainy day fund won’t let the larger rainy day fund remain in an account, opting instead for a big-screen television. That makes no sense, especially when looking at the previous advice to build a rainy day fund for someone who has revolving credit card debt. Without more information, who would you bet on to blow the money? That seems a no-brainer.

I know the unaddressed issue is that these people are getting large tax refunds. That makes my head explode. If you have debt that you want to pay off, and you’re getting a significant refund, you’re managing your money horribly. Stop lending it to the government for free for up to 16 months. Keep your money and use it to avoid building up (or not paying down) those debts that you then use the refund to fix. This is not hard.

Yes, I think the author should’ve pointed this out. If people will spend a huge “windfall”, why not suggest that they manage it as twelve tiny “windfalls” instead?

2 thoughts on “Introducing Economic Breezefalls”

  1. I think it depends on what he does and what he thinks his risks are.
    In my situation, I would pay the loan without even thinking about it. I’m 25, have a good paying job (with good disability benefits) in a field that’s pretty wide open right now, no wife, no kids, and in reasonably good health. If I lost my job, I could pick up another one in two months fairly easily. If I got sick or hurt, my employer would take care of me. If my loans are at 9% and my rainy day fund is in a money market or something at 4%, I’m losing 5% a year. With something as easily solved as dumping $8k to a high interest student loan, it seems like a no-brainer to me.
    My answer would probably be quite a bit different if I were 45 year old UAW with high cholesterol, and married with kids.

  2. Valid points. The context of the person receiving the “windfall” is important. My analysis is based more on what kind of debt a person should have if he needs to buy a house, for example. Lenders will look at those student loans differently than credit cards. And they look at cash reserves, too. I’m all for paying them down if the person can’t get a better return on the money, but student loans, even at 9%, don’t look as bad in my scenario.
    My larger point, though, was the inconsistency of the writer. People with student loans only would spend the windfall, but people with credit card debt would save it for a rainy day. I’m not buying that. And I’ve been in the heavy credit card debt situation. It’s a vicious place to be, mentally. And lenders definitely don’t like it, as I found out.
    Also, don’t set your taxes up to get a huge windfall every spring. That’s a dumb financial move and the easiest to correct.

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